Corrected Note (See page 11 for details). Note originally published 23 May 2011.

Transcription

1 Corrected Note (See page 11 for details). Note originally published 23 May Thomas Cook Group Strong business and stable credit, Initiate with N Thomas Cook is one the largest leisure travel companies in providing charter packages, tailor made itineraries to retail customers and wholesale business where the company operates as an intermediary between suppliers and other agents as well as travel related financial services. Key source markets for Thomas Cook are the UK (29% of FY10 EBIT) followed by Northern (22%), West/East (20%), Central (14%), Airlines Germany (13%) and North America (2%). While trading conditions have been tough in the last 2 years, particularly in the UK, operating performance has also been impacted (to a greater extent in some cases) by exchange rate movements (weakness in GBP vs. Euro), fuel costs as well as exceptional costs due to the volcanic ash cloud in 2010 and Swine flu in However, underlying profitability has remained broadly stable as the management have focused on cost savings and synergies from acquisitions. Thomas Cook has grown its business through acquisitions and by improving key drivers such as level of controlled distribution, differentiated product offering, level of in-house flying and online bookings penetration. This improvement has required investments which have limited FCF generation. Net adjusted leverage at 1H11 was 4.2x (net debt of 1,094m) up from 3.6x at FY10 due primarily to the seasonal working capital swing of c. 600m. Thomas Cook refinanced its capital structure in 2010 through the issue of 7.75% 300m due Jun-17 and 6.75% 400m due Jun-15 (rated BB-/S by both S&P and Fitch). We initiate coverage of Thomas Cook with a Neutral recommendation (5yr CDS 365/395bp). While the company is strongly positioned to benefit from any improvement in underlying trading conditions as well as ongoing delivery of cost savings, we do not expect significant change in its credit profile in the near term given limited cash flow generation and a high operating lease base. At current levels, we prefer Thomas Cook bonds (which are yielding 6.8% for the 2015 bonds and 7.9% for the 2017 bonds) to RCL 2014 bonds and IAG 2016 bonds. We are also changing our OW recommendation on RCL 2014 bonds to N on relative value as the z-spread has tightened from 535bp (1 Sep 2010) to 286bp now. Thomas Cook is a less capital intensive business than both RCL and IAG, has shown a more resilient operating performance historically and is less exposed to fuel oil prices. an Credit - Consumer & Retail Raman Singla AC J.P. Morgan Securities Ltd. Table 1: Bond peer comparison Issuer Bond recommendation Coupon Maturity Rating Amount Mid price YTW z-spread Thomas Cook Overweight 7.75% 22-Jun-17 NR; BB-/S % 515 Thomas Cook Overweight 6.75% 22-Jun-15 NR; BB-/S % 414 Royal Caribbean Neutral 5.63% 27-Jan-14 Ba2/S; BB/S 1, % 286 IAG (British Airways) Neutral 8.75% 23-Aug-16 B2/S; BB-/S % 507 Source: Bloomberg, J.P. Morgan. All prices as of 20 May 2011 opening levels See page 11 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Thomas Cook enjoys a very strong market position in the an leisure travel market Thomas Cook is one of the largest leisure tour operators in with key markets of the Netherlands, the UK, Belgium, France, Germany, the Nordics and Canada. The total size of the world leisure travel market in 2009 was estimated by Thomas Cook to be 820bn and within that Thomas Cook s core markets accounted for 33.4% ( 274bn). Within its core markets, Thomas Cook is part of the Travel intermediaries segment which was 96bn in size with the remaining market made up of Direct suppliers. Thomas Cook operates in all the 3 major businesses under the Travel intermediaries segment Mainstream Travel, Independent Travel and Financial Services. Mainstream travel consists of charter packages which include flights, hotels and transfers. Independent travel consists of tailor made itineraries and wholesale business in which the company operates as an intermediary between suppliers and other agents. Travel related financial services include pre-paid foreign exchange, travel assurance and travel finance products such as credit cards. Thomas Cook is a public company with almost all shares being in free float. Thomas Cook s current form arose as the 52.8% stake in Thomas Cook held by Arcandor was liquidated to bondholders in Arcandor as a result of Arcandor's bankruptcy in Figure 1: Travel market - Thomas Cook core markets Total market size 274bn Travel intermediaries 35% Mainstream travel 11% Direct suppliers 65% Independent travel 23% Financial services 1% The UK is Thomas Cook s biggest market contributing 29% of EBIT followed by Northern with 22%, West/East with 20%, Central with 14%, Airlines Germany with 13% and North America with 2%. Sales breakdown by region FY10 Sales 8,890m EBIT breakdown by region FY10 EBIT 391m Airlines Germany North America 11% 4% Northern 11% UK 34% Airlines Germany 13% North America 2% Northern 22% UK 29% West/East 19% Central 21% West/East 20% Central 14% 2

3 Table 2: Business description UK Central West/East Northern North America Airlines Germany 1 Number of passengers 7.8m 3.6m 3.1m 1.4m 1.1m 5.7m Number of aircraft Top destination markets (market position and market share) Turkey (1, 50%) Egypt (2, 39%) Tunisia (1, 60%) Balearics (1, 32%) Canaries (2, 24%) Turkey (2, 13%) Egypt (2, 14%) Antalya Djerba Monastir Crete Majorca (1, 50%) Gran Canaria (1, 45%) Tenerife (1, 40%) Rhodes (1, 35%) Antalya (1, 25%) Mexico Dominican Republic Cuba 1 Airlines Germany is Thomas Cook s stand-alone airlines business in Germany which sells airliner seats to Thomas Cook, other tour operators and seat only customers Profitability varies across regions of operations. Key factors determining profitability include level of controlled distribution, differentiated product offering, level of inhouse flying and level of online bookings. Table 3: Key business performance drivers UK Central West/East Northern North America Controlled distribution 72% 24% 57% 84% 14% Retail outlets 1,011 1,321 1, Internet distribution 32.6% 7.2% 21.4% 60.9% 36.7% Thomas Cook airline share 92% 43% 58% 85% 49% Exclusive accommodation 40% 24% 42% 90% 70% As a result of higher controlled distribution and higher internet penetration, for Thomas Cook, Northern is the most profitable business followed by Airlines Germany and the UK. Figure 2: EBIT margin by region 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% UK Continental Northern Airlines Germany North America FY08 FY09 FY10 Thomas Cook s key operating objectives are: Mainstream Travel: to reduce accommodation costs (accommodation costs as % of sales in FY10 of 32.5% from 33.7% in FY09), deliver savings in group aviation costs ( 19m savings achieve in FY10) and increase in-house distribution of mainstream travel products (controlled distribution increased to 52% in FY10 from 51% in FY09). In Travel related financial services the company aims to protect and grow financial services contribution to group profit. In the Independent Travel segment, the company aims to increase independent travel sales as a proportion of group revenue (27% of group sales in FY10 from 25% in FY09), to achieve a top 3 market position in the an online travel agent market with a gross bookings value of 3.5bn ( 1.05bn in FY10). In terms of group profitability the company aims to increase EBIT margin by 100 to 150bp over the medium term. 3

4 Figure 3: Bookings by season (% change yoy) 12% 8% 4% 0% -4% -8% -12% Fuel & accommodation costs and exchange rates have been a bigger driver of operating performance than underlying trading Along with the economic downturn in 2008/09, the tourism industry also experienced a decline in overall number of tourists. Thomas Cook reported up to a 10% decline in cumulative bookings yoy during the seasons of Winter 08/09, Summer 09 and Winter 09/10. Most of the decline occurred in source markets of the UK and Continental while Northern remained more resilient. The latest trading season of Summer 11 has shown improvement in all markets except a moderate decline in West/East an market. However, in terms of reported results, exchange rate movements have had a greater impact on results as the weakness in the operating environment was to a great extent offset by cost savings and synergies from acquisitions. Winter 07/08 Summer 08 Winter 08/09 Summer 09 Winter 09/10 Summer 10 Winter 10/11 Summer 11 UK Continental Central West/ East Northern Sales in FY10 (year ending September 2010) declined 4.1% to 8,890m driven by high single digit declines in Central and East/West, mid-single digit declines in Northern, North America and Airlines Germany partially offset by 1.5% growth in the UK. However, in terms of underlying EBIT, group figure declined 5.7% to 391.4m (excluding the impact from air space closure due to volcanic ash cloud in 2010) driven primarily by a 23.5% decline in the UK to 123.9m while all other markets (with the exception of North America which is the smallest contributor to group EBIT) increased their EBIT from FY09. The severe decline in profitability in the UK business was due to a weaker GBP vs. Euro which increased the cost base by c. 160m only about half of which was offset by lower fuel prices and supplier negotiations. Sales ( m) 9,500 9,000 8,500 8,000 7,500 EBITDA ( m) ,000 FY07 FY08 FY09 FY FY07 FY08 FY09 FY10 4

5 FY09 results, however, reported 5.9% growth in sales to 9,269m and EBIT increased 13.4% to 415m resulting in 30bp increase in EBIT margin to 4.5%. Sales in the UK were flat at 3,098m while EBIT increased 13.1% to 162m driven by capacity control, shift to more profitable medium haul segment as well as savings in accommodation rates, merger synergies and cost saving initiatives partially offset by higher fuel costs and a weaker GBP. Sales in Continental (combined West/East and Central ) increased 10.5% to 4,000m and EBIT increased 19.3% to 127m driven by a weaker GBP as well as benefit from acquisitions while underlying sales declined 9% due to fewer passengers. Sales in Northern increased 9.0% to 1,059m while EBIT increased 0.2% to 86m as tougher trading conditions reduced profits in 1H09 despite an 8% increase in average selling prices. Table 4: Key drivers of EBIT performance % change over last year's EBIT FY09 FY10 Trading 6.8% -6.5% Fuel & accommodation -12.3% 51.1% FX impact -12.6% -64.8% Acquisitions 8.5% 0.0% Cost savings and merger synergies 30.3% 22.7% Depreciation 0.0% -8.2% Exceptional factors 1-7.4% -7.0% 1 Exceptional factor in FY09 was Swine flu and in FY10 was volcanic ash cloud impact Thomas Cook reported 1H11 results inline with our expectations. Sales in 1H11 increased 4% to 3,431m driven by 2.3% growth in UK to 1,023m, 6.7% growth in Central to 748m, 3.5% growth in West/East to 545m, 3.2% growth in Northern to 540m, 1.6% growth in North America to 241m and 4.3% growth in external revenue in Airlines Germany to 335m. Underlying EBIT declined to a loss of 166m from a loss of 130m in 1H10 driven by 48m decline due to reduced trading activity, 21m adverse impact from inflation, 22m impact from the disruption in North Africa ( 35m negative impact guided for 2H11) and 15m impact from the later Easter timing in 2011 partially offset by 27m benefit from lower fuel and accommodation costs and 43m benefit from cost savings. As such, Thomas Cook has a very high level of seasonality in its business which is an industry characteristic, with winter months reporting much lower profits (loss) which is offset by much higher volumes in summer months when most people in take their vacations. At the end of 1H11 Thomas Cook had hedged 88% of its expected fuel consumption for Winter 10/11, 88% for Summer 11 and 65% for Winter 11/12. Fuel is about 9-10% of the company s cost base and per management, to mitigate the impact from current high fuel prices, a c.2% increase cost of holiday will be needed some of which will be done through implementation of fuel surcharges. To mitigate the adverse impact from the London Olympics in 2012 leading to a lesser number of people taking vacations from the UK, the company is selling 300,000 packages for UK domestic as well as tourist traffic inbound for the UK for the games. 5

6 Limited cash flow generation due to ongoing exceptional costs and focus on acquisitions limits the potential for de-leveraging Thomas Cook has historically generated limited free cash flow which was due primarily to high exceptional costs. Exceptional cash costs in FY10 were 187m (including 74m due to the volcanic ash cloud related closures), 214m in FY09 and 185m in FY08. For FY11 the guidance for exceptional costs is c. 95m. Most of the exceptional costs have been due to the integration of acquisitions and restructuring initiatives. CFO in 1H11 was an outflow of 168m up from an outflow of 154m for 1H10 due to lower EBITDA partially offset by a 46m improvement in working capital. FCF was flat on 1H10 at 255m outflow due to lower capex. FCF in 1H11 LTM was an outflow of 26m. Figure 4: FCF breakdown m FY07 FY08 FY09 FY10 1H11 LTM EBITDA Interest Tax & exceptionals Working capital Capex FCF Table 5: Acquisition history m Target Date Stake Consideration Thomas Cook Services (Cyprus) Ltd 05-Jul-10 51% Essential Travel 30-Apr % FY Gold Medal 07-Apr % 65.6 Voyages Wasteels shops 01-Mar Met Hotels 02-Feb Airtrack Services Limited 21-Oct % 1.4 FY Jet Tours 04-Aug TriWest Travel Holdings 01-Aug Viajes iberoservice Espana SL 01-May-08 65% Neckermann Urlaubswelten GmbH & Co 100% Thomas Cook Egypt 04-Apr % Elegant Resorts Limited 03-Apr % Thomas Cook India 27-Mar % Hotels4U.com 14-Feb % 39.0 Urlaub.de.GmbH 01-Nov-07 FY Travel Plus 31-Aug % 2.5 MyTravel Group Plc 19-Jun % 2,251.4 FY07 2,254 6

7 Table 6: Capitalisation - 1H11 m Thomas Cook has remained acquisitive over the last few years. The most notable acquisition was that of My Travel Group Plc for 2,251m in June In April 2010, Thomas Cook acquired Think W3 Ltd (the owner of Essential Travel) which is a provider of travel insurance, airport parking and airport hotels in the UK. In July 2010, Thomas Cook announced the acquisition of Oger Tours GmbH which provides package holidays to Turkey from Germany. In October 2010, Thomas Cook announced the merger with The Co-operative Travel in the UK which did not involve an upfront cash payment. This transaction, while still under review of the Competition Commission, will make Thomas Cook the largest UK high street travel retailer with c.1,200 shops (803 from Thomas Cook and 401 from The Co-operative) and is guided to provide 35m of synergies. Net debt at the end of 1H11 stood at 1,094m up from 952m at 1H10. Thomas Cook had a 590m headroom under its revolving credit facility at the end of 1H11 up from 482m at 1H10. Debt at Thomas Cook at 1H11 consisted of a 200m term loan, a 850m revolving credit facility which was drawn 260m, 7.75% 300m bonds due 2017 and 6.75% 400m bonds due 2015 as well as other bank loans and bank overdrafts totaling 214m and 71m in finance leases. Cash on balance sheet was 305m at 1H11. The term loan and the revolving credit facility mature in May 2013 and are extendable for up to 2 years. Thomas Cook obtained BB-/S ratings from both S&P and Fitch during 1H11 as was required under the terms of the two bonds issued in Thomas Cook does not have any major short near term maturities. Net adjusted leverage at the end of 1H11 stood at 4.2x (net debt to EBITDA was 2.2x) up from 3.6x at FY10 due to seasonality in Thomas Cook s business resulting in a working capital swing of c. 600 between 1H and 2H. Coupon Maturity Rating Total amount Amount outstanding Amount available Bank overdrafts 44.3 Term loan L % Revolving credit facility L % Other bank loans High yield bond 7.75% 22-Jun-17 NR; BB-/S High yield bond 6.75% 22-Jun-15 NR; BB-/S Finance leases 71.4 Total debt 1,398.7 Cash & cash equivalents Net debt 1,

8 Table 7: Peer comparison m Thomas Cook TUI Travel Rating NR; BB-/S NR; NR Year end September September Period 1H11 LTM 1H11 LTM Sales 9,012 13,727 Gross profit 2,110 1,248 Gross margin 23.4% 9.1% EBIT EBIT margin 3.6% 3.0% EBITDA EBITDA margin 5.6% 4.8% Interest FFO CFO FCF Total debt 1,399 1,560 Net debt 1,094 1,182 Operating lease adjustments 2,094 4,632 Pension deficit EBITDA/Interest 3.0x 3.3x EBITDAR/ (Interest + Rents/3) 3.0x 3.2x Adjusted FFO/ net debt 11.6% 11.1% Net debt/ EBITDA 2.2x 1.8x Total debt/ EBITDA 2.8x 2.3x Adjusted net debt/ EBITDAR 1 4.2x 4.7x Adjusted total debt/ EBITDAR 1 4.5x 5.0x 1 Lease adjusted using an 8x multiple for annual operating lease rental payments 8

9 Table 8: Thomas Cook summary financials m FY07 FY08 FY09 FY10 LTM FY11E FY12E Sales 6,405 8,112 9,269 8,890 9,012 9,366 9,632 Gross profit 1,525 1,885 2,251 2,144 2,110 Gross margin 23.8% 23.2% 24.3% 24.1% 23.4% EBIT EBIT margin 4.8% 4.5% 4.5% 4.1% 3.6% 4.0% 4.1% EBITDA EBITDA margin 5.8% 6.2% 6.2% 6.1% 5.6% 5.8% 5.8% Interest EBITDA Interest Tax Other operating items FFO Working capital CFO Capex FCF Total debt ,130 1,143 1,399 1,148 1,147 Net debt , Operating lease liabilities 1,465 1,318 1,562 2,094 2,094 2,094 2,094 Pension deficit EBITDA/Interest 4.9x 4.0x 3.4x 3.4x 3.0x 3.3x 3.5x EBITDAR/(Interest + Rents/3) 4.1x 3.7x 3.3x 3.2x 3.0x 3.2x 3.3x Adjusted FFO/ net debt 54.8% 24.1% 16.1% 15.2% 11.6% 16.9% 17.1% Net debt/ EBITDA -1.9x -0.1x 1.2x 1.5x 2.2x 1.5x 1.4x Total debt/ EBITDA -0.3x 1.4x 2.0x 2.1x 2.8x 2.1x 2.1x Adjusted net debt/ EBITDAR 1 1.4x 1.9x 2.9x 3.6x 4.2x 3.6x 3.5x Adjusted total debt/ EBITDAR 1 2.5x 3.0x 3.5x 4.0x 4.5x 4.0x 3.9x, J.P. Morgan equity estimates 1 Lease adjusted using an 8x multiple for annual operating lease rental payments 9

10 Table 9: High yield bond covenants Issuer Issue Maturity Optional redemption Security Guarantors Thomas Cook Plc 400m 6.875% and 300m 7.75% Guaranteed Notes 2015 for bonds and 2017 for bonds Make whole at B+50bp None Condor Flugdienst GmbH, TC Touristik GmbH, Thomas Cook AG, Thomas Cook Airlines Belgium NV, Thomas Cook Belgium NV, Thomas Cook Group Treasury Limited, Thomas Cook Retail Limited, Thomas Cook SAS, Thomas Cook Tour Operations Limited, Thomas Cook UK Limited, Thomas Cook Airlines Limited, Thomas Cook Scheduled Tour Operations Limited, Thomas Cook Airlines Scandinavia A/S, Thomas Cook Canada Inc. and Bucher Reisen GmbH. Change of control Investor put at 100 There must be a change of control (a person acquiring more than 50% of allotted share capital or voting rights of the issuer or the sale/disposition of substantially all of the assets of the issuer and its subsidiaries, taken as a whole, to any person) AND either (i) the notes do not have an IG rating from at least one rating agency at the time the CoC occurs and is not able to acquire/maintain an IG rating during the CoC period (i.e. from announcement date and ending 90 days after the date of the CoC) from at least one rating agency; (ii) the notes do have an IG rating from at least one rating agency at the time the CoC occurs but at anytime during the CoC period, (a) the rating agency rates the notes as HY and it is not restored to an IG rating or replaced by an IG rating by another rating agency during the CoC period or (b) the rating agency withdraws the rating on the notes and it is not replaced by an IG rating by another rating agency during the CoC period. Events of default Negative pledge Source: Offering memorandum Non-payment of principal for 7 days or more; non-payment of interest for 14 days or more Cross default of more than 50m Breach of other obligations under notes or trust deed (which are not remedied within 30 days) Certain events related to insolvency/winding up of the issuer. No material subsidiary (sales, EBITDAR or gross assets is 10% or more than the Group s total) will grant any security to any debt (seemingly including credit facilities), other than permitted security (up to 450m of debt is allowed to be secured ahead of the notes), unless it also provided to the notes. 10

11 Corrected Note: Disclosures corrected. Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. Important Disclosures Market Maker/ Liquidity Provider: J.P. Morgan Securities Ltd. and/or an affiliate is a market maker and/or liquidity provider in Thomas Cook Group, British Airways, Royal Caribbean Cruises. Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for British Airways within the past 12 months. Other Significant Financial Interests:J.P. Morgan owns a position of 1 million USD or more in the debt securities of Thomas Cook Group, British Airways, Royal Caribbean Cruises. British Airways - J.P. Morgan Recommendation History Date Rating Instrument 23 Mar 11 Overweight 5yr CDS Recommendation changes made by J.P. Morgan Credit Research Analysts in the subject company over the past 12 months (or, if no recommendation changes were made in that period, the most recent change). Royal Caribbean Cruises - J.P. Morgan Recommendation History Date Rating Instrument 23 May 11 Neutral 5.625% 1, Recommendation changes made by J.P. Morgan Credit Research Analysts in the subject company over the past 12 months (or, if no recommendation changes were made in that period, the most recent change). Explanation of Credit Research Ratings: Ratings System: J.P. Morgan uses the following sector/issuer portfolio weightings: Overweight (over the next three months, the recommended risk position is expected to outperform the relevant index, sector, or benchmark), Neutral (over the next three months, the recommended risk position is expected to perform in line with the relevant index, sector, or benchmark), and Underweight (over the next three months, the recommended risk position is expected to underperform the relevant index, sector, or benchmark). J.P. Morgan's Emerging Market research uses a rating of Marketweight, which is equivalent to a Neutral rating. Valuation & Methodology: In J.P. Morgan's credit research, we assign a rating to each issuer (Overweight, Underweight or Neutral) based on our credit view of the issuer and the relative value of its securities, taking into account the ratings assigned to the issuer by credit rating agencies and the market prices for the issuer's securities. Our credit view of an issuer is based upon our opinion as to whether the issuer will be able service its debt obligations when they become due and payable. We assess this by analyzing, among other things, the issuer's credit position using standard credit ratios such as cash flow to debt and fixed charge coverage (including and excluding capital investment). We also analyze the issuer's ability to generate cash flow by reviewing standard operational measures for comparable companies in the sector, such as revenue and earnings growth rates, margins, and the composition of the issuer's balance sheet relative to the operational leverage in its business. 11

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